12/27/1999 @ 12:00AM

One ratio does not fit all

It’s a common complaint among investors these days that the textbook securities valuation tools, such as price-to-earnings and price-to-book value ratios, just don’t seem to work anymore. In some cases–Internet stocks or Japanese small-caps, for example–they don’t. But it still pays to do your homework. The trick is knowing which ratios work and when to use them.

Thomas S. White, a Chicago-based money manager, each month crunches numbers on more than 2,500 global companies in nearly 50 countries. He also analyzes prices and fundamental data going as far back as 1982 and has developed a stock-picking system based on which analytical tools work and which don’t, depending on country, region or industry group.

Instead of focusing on a single ratio–P/E, say, or price-to-cash-flow–for all types of stocks, White applies different measures for each sector, country or region. White’s team of ten analysts use the numbers as a starting point for closer fundamental analysis.

Does it work? Apparently it does. Thomas White International manages $440 million, mostly institutional money. Since 1991 White’s international portfolios have returned an annualized 11.2%, compared with a 9.4% annual return for the Morgan Stanley Capital International World ex U.S. index. Over the past five years, the U.S.-registered Thomas White International Fund, a mutual fund with $41 million in total net assets, has returned 13.4%, against 8.1% for the MSCI All Country ex U.S. index and 9.6% for the average international fund tracked by Morningstar, a funds-rating outfit.

Before starting his own firm in 1992, White spent 13 years at Morgan Stanley Asset Management. Many of the trends he saw unfold in the U.S. during those years are now taking shape elsewhere. Europe, for example, is starting to see more shareholder-driven reforms and intense M&A activity.

With these changes, White says, come big changes in how you pick stocks. From 1982 to 1988, he notes, the use of conventional valuation ratios was effective in the U.S. market. But from 1989 to 1991, as leveraged takeovers became common, the high levels of debt made it harder for investors to value companies using the old methods.

Throughout the 1990s the emphasis shifted from valuing trailing earnings to analysis of earnings upgrades and downgrades, with new emphasis being placed on more sophisticated multiples such as EV/EBITDA. The same transformation, White notes, began in Europe around 1995 and will proceed faster than in the U.S.

White begins his stock-picking process by sorting companies into one of 163 global “valuation groups.” For the most part, the groupings are made along industry lines. In Europe, White separates British firms from Continental European ones in some industries; in others they remain together.

Food and beverage companies, for example, are split several ways in White’s system. Nestl and Danone belong in international Continental staples, while Diageo and Cadbury Schweppes are part of a separate group of big U.K.-based staples companies. The rest of the food and beverage companies–in both the U.K. and on the Continent–are grouped together. For small markets–New Zealand, Indonesia and most of Latin America and Eastern Europe–White does not make industry distinctions at all.

“Evaluating companies by global industry groups, all banks or paper companies in the world, for example, is an interesting idea,” White says, “but we’ve found that it doesn’t really work.” The reason: Factors beyond valuation, such as local institutional demand, takeover premiums, differences in market cap and local investor preferences, can have a big impact on prices.

Thus in some countries, important local distinctions are made. Hong Kong Red Chips–shares of Chinese firms listed in Hong Kong, such as Citic Pacific or China Telecom, are treated separately from the rest of the Hong Kong market, because they tend to be more volatile and have different accounting standards. Likewise, small Hong Kong banks, such as Dao Heng, belong in a different group from such giants as HSBC Holdings.

The table lists 12 stocks currently favored by White. One of his top picks, ST Microelectronics, would make most value investors cringe: It trades at 56 times 2000 estimated earnings and more than six times sales. But ST Micro’s estimated earnings growth rate in 2000 should be nearly 40%, well above the European technology group average of 29%. White also likes the company’s technology and commitment to R&D.

KPN, the Dutch telecom operator, is another stock on White’s short list. The most valuable indicators in the Continental telecom group, according to White, are price to cash flow, dividend yield and price to book. KPN is cheaper than its peers on two of these counts. KPN sells for 4.4 times book; the sector for 6.5. Its price to cash flow is 11.3 versus 12.5 for the sector.

In emerging markets one of White’s top picks is Cemex, the Mexican cement maker. Selling for a ratio of six times enterprise value (market cap plus long-term debt) to EBITDA cash flow (earnings before interest, taxes, depreciation and amortization), Cemex looks cheap. More important, White notes, earnings revisions have been very strong. In the past three months, analysts have hiked their estimates for Cemex’s year 2000 earnings by 6.1%, as against a 1.4% gain for other Mexican cyclicals.

Subscribers to White’s research reports–a separate business from his management operation–each month receive in the mail a fat book with hundreds of pages of nothing but numbers, including price and valuation data on more than 2,500 stocks, along with his analysts’ recommendations. Institutions pay about $5,000 per month for White’s analysis. Not the most exciting read, but that’s not the point, says White: “A lot of fund managers want to think of themselves as fighter pilots. But managing money is more like running a factory or even a farm. You have to get up early each day and grind away at it if you want consistent results.” The fact that few have such patience gives White and his customers an extra edge.